ORANGE COUNTY, CA-While most experts in the sector vehemently deny that net lease has become too safe, Sidney Domb, president of UTF, has a different take on the matter. His thoughts are that net lease could indeed be too safe and not provide enough yield for investors—IF their leases are set up incorrectly.
“We started doing this in 1972, so we've been in this for 40 years,” Domb says. “When we started, the concept that we had was that we do not have any staff outside fixing anything, so let's not buy anything unless there's nothing we have to do but collect a check. We sat down with an attorney—one we've been using for 28 years—and made up a bond net lease that said the tenant does everything. Even in the event that there's a condemnation, the tenant has to make an offer to purchase the property.”
Domb says his firm is meticulous when setting up its net leases. “When we're doing a sale-leaseback, we sit down with a company and say, 'We're going to give you the money and take the title, and for all intents and purposes, it's like we got on a ship and went to China. The only time you'll hear from us is if the rent doesn't come in.' Make it clear in the lease that the tenant is paying for everything. If you're going to buy an existing deal, you can't change the lease—it's already in place—so you should get a bigger return.”
Too safe? Too boring? “The reality of it is, people tend to get to a point in life where they think when something's good for too long, then it has to get bad,” says Nicholas Schorsch, chairman and chief executive of American Realty Capital. “That's just not the case with net lease. In real estate, the fundamentals are incredible. The cost of capital, the cost of debt has never been lower. The Feds will keep interest rates low and keep pumping money into the system, and real estate really hasn't compress yet. This hasn't changed.”
Schorsch says his firm has bought millions of dollars of net-leased assets in the last four to seven months, and these have averaged in the mid- to high-7's cap, all essentially investment grade. “It's almost like it was in 2006, but now the cost of debt is 2.5%--it was a lot higher in '06. We're seeing a dramatically better spread than we've seen before, and the market couldn't get better. There's nothing that could happen to make it better than it is today.”
Eventually this will change, Schorsch says, so investors should hold onto their assets until the next compression and then sell. “You've got spreads that are almost 4% between the cost of debt and the average cap rate. When will the next compression hit? We thought it would have happened already, but it will happen when the economy gets better and unemployment starts to drop—then it will be a great time to start selling. Real estate is cyclical, and we just happen to be in the buying part of the cycle.”
Paul McDowell, CEO of CapLease, says he's not sure he would qualify the sector as being “too safe.” “It is a safe sector. The cash flows are long-term cash flows that produce good long-term income. Our dividend yield is 3.8% as of February. We have a premium yield only to the REIT universe, but when you look at the risk-free rate, you have to look at where the 10-year treasury is, and that's at about 1.92%. So here you have safe cash flows that produce what I think is quite a high yield.”
As GlobeSt.com reported last week, all REITs are not created equal was the main message conveyed by the illustrious speakers on the REIT Power Panel, part of the RealShare Net Lease conference—organized by the ALM Real Estate Media Group—held Tuesday at the Convene conference center in midtown Manhattan. Nearly 300 industry professionals were in attendance.
But at least one CRE veteran in the group, Benjamin Butcher, CEO, president and chairman of the board, STAG Industrial, noted the wisdom of keeping these investments for a while rather than rushing to sell. “These assets are meant to be bought and held as cash flow.”
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Carrie Rossenfeld
Carrie Rossenfeld is a reporter for the San Diego and Orange County markets on GlobeSt.com and a contributor to Real Estate Forum. She was a trade-magazine and newsletter editor in New York City before moving to Southern California to become a freelance writer and editor for magazines, books and websites. Rossenfeld has written extensively on topics including commercial real estate, running a medical practice, intellectual-property licensing and giftware. She has edited books about profiting from real estate and has ghostwritten a book about starting a home-based business.
